Morningstar Wide Moat ETF - How to invest in a moat?

Investing in the stock market only from the outside seems simple. It is especially difficult for long-term investors who want to buy companies with the intention of keeping them in their portfolios for the next 5-10 years. For this purpose, they must choose companies for which time will be an ally, not an enemy. Such enterprises must have sustainable competitive advantages. This will allow such companies to increase or maintain their operating margins and at least maintain their market share. In the investment environment, companies that have a lasting market advantage are said to be: they have a moat. Today's article will allow the reader to understand what market advantages are, how to invest in a moat on the capital market and what it is famous for Morningstar Wide Moat ETF. We invite you to read!

Warren Buffett's look

The term moat was introduced into the investment vocabulary by none other than the Oracle of Omaha. Warren Buffett he mentioned the moat for the first time in 1991 in a speech to MBA students. Then he said that the most important thing in the assessment of enterprises is to determine how strong the moat surrounding the company's business is. During the lecture, Warren Buffett recognized that investors should look for companies where like "large capital and large moat". According to the oracle of Omaha, the most important situation is when a company constantly achieves an increasing advantage over the competition. He described his opinion on the subject in a letter to investors of Berkshire Hathaway in 2005. In one of the passages, Buffett mentioned that every day a company can improve its moat (i.e. competitive advantage) or worsen it.

The moat can be improved by reducing unnecessary costs or increasing customer satisfaction (e.g. by improving customer after-sales service). Another idea to increase your competitive advantage is to develop new products and services that will better meet customer expectations. A great example is Apple, which has been able to meet the expectations of its customers since the XNUMXs. The company has proven its innovation by successfully launching smartphones and iPods.

How can you make your moat worse? In a very simple way. It is enough for the company to stop controlling costs or worsen customer service. In addition, companies that cannot cope with the technological race in their industry can worsen their moat. As an example, Nokia can be given, which very quickly became an outsider from the world's largest manufacturer of mobile phones. The reason was a miss "smartphone revolution". Another example is Kodak, which despite being the first to develop a digital camera, remained faithful to film-based products. As a result, at present Kodak does not count on the camera market.

What is a moat?

In this part of the article, we will not analyze the military use of the moat in defensive buildings. We will focus on the moats that companies can have over their competitors. In order to invest in a moat, you need to know exactly what the advantages can be and how long they can be maintained. There are several ways in which a company can gain an advantage over other companies operating in the same industry. In a moment, we will present examples of the formation of a moat.

Cost advantages

This is an advantage resulting from lower production costs, which is very difficult to replicate by the competition. The cost advantage may come from lower labor costs. This may apply to both domestic and foreign competition. The advantage over the domestic customer may result from placing the factory in a place with high unemployment. Therefore, the salary paid to employees will be lower than for a company operating in the same industry but paying more to its employees. In the case of foreign clients, the differences in wages can be very large. Another example of a cost advantage could be access to cheap and close-by raw materials. Thanks to this, the company can produce cheaper than the competition, which has to import raw materials from intermediaries. Lower production costs allow lower prices, which makes the company's products and services more competitive. An example could be Chinese companies from 10-15 years ago, which, thanks to lower production costs, were more competitive on global markets.

Economy of scale

This is a situation where a company achieves a moat by being much larger than its competitors. For this reason, it can achieve some cost savings, which allows it to lower prices compared to its competitors. These can be, for example, optimization of production lines, which causes the unit price of the product to decrease. The greater the outlays necessary to be incurred by the enterprise to build economies of scale, the more durable is the competitive advantage. An example are car manufacturers who, in order to make production profitable, must build an appropriate scale so that the unit price of the products is attractive enough for customers. It is not surprising then that the costs of "entry" into this market for a new company are huge.

High product replacement costs

It is also worth looking for companies that have the so-called "switching costs", i.e. the cost of switching or finding an alternative to a product or service. For the customer, the change in their habits is too strong for them to want to change the current product for a cheaper substitute. Customers are an example Apple Lossless Audio CODEC (ALAC),who are so attached to iOS and their smartphones that they don't want to  think about "moving" to phones with Android software. Another example is the Bloomberg investment terminal. Most managers of large investment funds and investment analysts use these terminals and the cost (time) they would have to incur to learn a new terminal is so high that many funds do not want to use cheaper alternatives. The higher the switching cost, the easier it is for a company to pass on rising costs to its customers. Of course, if the company does not care about its customers, sooner or later the cost of switching will be lower and lower. As a result, there will be a greater churn of customers.

Intangible assets

Source: wikipedia.org

These are the company's assets that are not tangible but have a very high value. Sometimes they are a key component of competitive advantage. An obvious example is patents, which protect creators from unlawful copying. Patents are particularly important in the pharmaceutical industry, as drugmakers can reap staggering margins before legitimate competition from generics arises. Patents can also cover production methods, product shape, etc. Another example of intangible assets is brand value. Examples include Coca-Cola and Pepsi, which have a strong portfolio of recognizable brands. Smaller producers of sweet drinks or salty snacks do not have such recognizable global brands. For this reason, when expanding into new markets, they must allocate significant funds to advertising. Another example of significant intangible assets that give an advantage over the competition may be licenses granted by the government (e.g. for the extraction of raw materials). These factors can contribute to the improvement of the company's margin.

Soft moat

This is a particularly important moat, which is difficult to capture at first glance. Despite its "invisibility", it can have a very real impact on the company's revenues and profits. An example may be a corporate culture that supports innovation. Another soft moat can be owners and managers who can push the organization to the next level. A great personification of such leaders is Jeff Bezos or Steve Jobs.

Network effects

The phenomenon of the network effect can be a very important moat for an enterprise. The network effect arises when the product improves the more users join it. Social platforms are a great example. The more users who want to join the platform, the more sense it makes to be on the platform. This is due to the fact that more and more content and people worth contacting (friends, family, work colleagues) appear on the platforms. An example could be e.g. Facebook or TikTok.

Source: wikipedia.org

Sometimes the network effect allows you to improve the quality of service. An example is Uber, which, thanks to a large number of potential customers, encourages drivers to join the platform. The more drivers there are, the easier it is to find customers because the waiting time for the vehicle is shorter and the prices are more affordable. Mentioning the network effect, it is impossible not to mention Visa and Mastercard, which have become the "standard" in the way of paying for purchases in the countries of the European Union, the United States, Canada, Australia, the United Kingdom and New Zealand. In addition, these cards are accepted in most countries around the world (with slightly less availability than in the previously mentioned countries).

How can you invest in a moat?

Investing in a moat can be done in various ways. It can be both an individual selection of companies for the portfolio or entrusting your money to professionals who create a product tailored to the client's needs.

• Individual share purchase

Individual selection of stocks may seem like a simple matter, but to choose a few or a dozen "best ideas" It's not that easy for an equity portfolio. This requires a thorough analysis of the operational activities of individual companies. Then, study the market environment and compare the company's and competitors' products or services. This requires a lot of time and for investors with little capital this route may be suboptimal. As we mentioned in another article, increasing savings in the initial phase of building financial independence is more important than the rate of return achieved. Therefore, devoting several dozen or even several hundred hours to an in-depth understanding of the business can distract the investor from more productive activities such as additional work or improving his professional qualifications, which will translate into higher earnings and a higher rate of savings.

Own research also has its advantages. It significantly improves the understanding of business models, which can help in your own career (professional or own business). Another plus is a deeper understanding of the processes that take place in the economy or the capture of new trends that will shape the reality in the future (who knew what Netflix was in Poland in 2012?). After the selection of companies, the investor will start buying shares on the market. Then there will be a "boring" period of monitoring the activities of enterprises (at least once a year).

• Choosing a company and investing with derivatives

This is a similar investment method, only it requires the investor to choose other instruments that give exposure to selected companies. Instead of "normally" buying stocks, an investor may choose to buy derivatives that give exposure to companies. It is a solution that can allow you to use financial leverage or build investment strategies (bull spread or long call on LEAPS) that will allow you to earn on the right selection of companies for your portfolio. The disadvantage of using e.g. futures contracts is the possibility of exposing yourself to the risk of financial leverage. In this case, it may happen that the loss of the position will be greater than the investor's capital. For this reason, investing with leverage will require good risk management.

• Acquisition of an ETF with exposure to this market

This is one of the easiest ways to invest in companies that are supposed to have a strong market moat. Thanks to this, the investor can save a lot of time that he would spend on analyzing companies with strong competitive advantages. The advantage is also the costs, which are much lower than in the case of actively managed investment funds. The disadvantage of this solution is that usually ETF invests in several dozen companies with "wide moats", which means that the rate of return is lower than in the case of investing in the most growing ones in the entire index. Another idea to use an ETF is to initially buy to have exposure to companies in this sector and then start analyzing the components of the ETF on your own. After making the selection, you can sell shares in the ETF and then invest in your "best ideas" for the funds received.

• Buying fund units that will invest in the moat

It is a solution that is a choice for people who prefer more sophisticated investment strategies. The best funds focusing on investing in value can achieve a rate of return well above the market average. Of course, past performance is not a guarantee of similar profits in the future. It is also worth looking at the amount of fees and their structure. The clients of investment funds, which charge a fixed, large management fee, are in the worst position. This means that each year the client "pays" generous remuneration to the managers without the guarantee of achieving rates of return exceeding the results of the indexes. It's much better when the fund charges a low, fixed management fee and charges an additional commission on performance that exceeds the rate of return achieved by the benchmark.

• Acquisition of Berkshire Hathaway shares

Investing in the moat can also be done through a company owned by the author of this phrase. This is an idea for people who believe that Warren Buffett can still achieve a rate of return higher than the stock index. Of course, past results are no guarantee of profits in the coming years. But the consistency with which Warren Buffett stays at the top among value investors is truly respectable. Also, don't forget that Berkshire Hathaway (led by Warren) achieves an average annual rate of return in excess of 20% per year. Skeptics may raise the argument of the Oracle of Omaha's advanced age, which raises the question of how such an institution would fare without a "man of the institution" like Buffett.

Examples of companies with a moat

As we mentioned earlier, you can invest in the moat, for example, with ETFs. One of the most famous ETFs that allows you to invest in this type of company is VanEck Morningstar Wide Moat ETF. By purchasing this ETF, the investor receives exposure and companies with a high competitive advantage (i.e. the moat). The ETF in question has assets under management of $6,8 billion (as of December 2). It is a relatively cheap way to invest as the annual management fee is 0,46%. According to data provided by VanEck, the fund has 48 companies in its portfolio. It is worth noting that even after fees, the ETF from the moment of its establishment (2012) achieved a higher rate of return than S&P 500 index. Here is a list of the top 10 positions in the aforementioned ETF:

• Etsy - 3,68%
• Biogen - 3,45%
• Gilead Sciences - 3,29%
• Mercadoliber - 2,90%
• Boeing - 2,78%
• Emerson Electric - 2,76%
• Zimmer Biomet Holdings - 2,68%
• Blackrock - 2,67%
• Wells Fargo - 2,63%
• Workday - 2,56%

Forex brokers offering ETFs and stocks

How to invest in a moat? Of course, the simplest option is to buy the mentioned shares, but for people who want to well diversify and balance their portfolio, investing in a moat through entire ETFs will be a better choice. An increasing number of forex brokers have quite a rich offer of stocks, ETFs and CFDs for these instruments.

For example on XTB Today, we can find over 3500 equity instruments and 400 ETFs, a Saxo Bank over 19 companies and 000 ETF funds.

Broker
End	Poland	Denmark	Cyprus *
Number of exchanges on offer	16 exchanges	37 exchanges	24 exchanges
Number of shares in the offer	approx. 3500 - shares circa 2000 - CFDs on shares	19 - shares 8 - CFDs on shares	approx. 3 - CFD on shares
The amount of ETF on offer	approx. 400 - ETF approx. 170 - CFD on ETF	3000 - ETF 675 - CFD on ETF	approx. 100 - CFD on ETF
Commission	0% commission up to EUR 100 turnover / month	according to the price list	Spread depends on the instrument
Min. Deposit	PLN 0 (recommended min. PLN 2000 or USD 500, EUR)	0 PLN / 0 EUR / 0 USD	PLN 500
Platform	xStation	SaxoTrader Pro Saxo Trader Go	Plus500 platform
	REVIEW	REVIEW	REVIEW
	CREATE AN ACCOUNT	CREATE AN ACCOUNT	CREATE AN ACCOUNT

* PLUS500 CY offer

CFDs are complex instruments and come with a high risk of losing money rapidly due to leverage. From 72% to 89% of retail investor accounts record monetary losses as a result of trading CFDs. Think about whether you understand how CFDs work and whether you can afford the high risk of losing your money.

Summation

You can invest in a moat in different ways. You can select companies yourself, or use ETFs or mutual funds that give exposure to this market. The moat is a permanent advantage over the competition. They may result from lower costs, economies of scale, patents held, high switching costs, corporate culture or the "network effect".

It should be noted that it is very difficult to capture the moat at the time of its formation. Competitive advantages are best seen in retrospect. For this reason, most investors, when looking for ways to invest in a moat, choose mature companies with an established position. It is best for the investor when he buys a growing company that is at the moment of building a moat. In such a situation, he will buy shares very cheaply, because it will be before the market fully realizes all the advantages that the company has.